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PCAOB Opens Discussion on Audit Firm Rotation

The
PCAOB on Tuesday launched a new phase of its examination of
potential limits on audit firm tenure with public companies. The
board voted to issue a concept
release on the topic. It plans to gather feedback by
mid-December and hold a public forum on the issue in March 2012.

According
to the release, the board is particularly focused on weighing the
advantages and disadvantages of audit terms of 10 years or greater.
The board is also mulling the scope of any potential requirement,
such as whether the rules would apply only to audits of the largest
public companies.

The
41-page document poses 21 questions about which the board is most
interested in gathering opinions. The topics range from the
appropriate length of the term, if term limits are imposed, to
implementation considerations. Comments are due Dec. 14.

“There
are, of course, considerable implementation challenges associated
with mandatory rotation. The concept release invites study and
consideration of whether there are ways to mitigate those
challenges,” PCAOB Chairman James Doty said in remarks at Tuesday’s
meeting. “But the reason to consider the concept is to resolve the
question to which the discussion of independence, skepticism and
objectivity always seems to return. That is the central question of
this concept release: Will term limits, set at some appropriate
length, with due regard for implementation complexities, reduce the
pressures auditors face to develop and protect long-term client
relationships to the detriment of investors and our capital markets?”

“With
this release, I hope to challenge critics and proponents alike to do
their homework, come forward with facts, and add meaningful depth to
the discussion, in order that we might reach resolution,” Doty said.

Cindy
Fornelli, executive director of the Center for Audit Quality, which
is affiliated with the AICPA, said, in a statement issued after the
meeting, “The CAQ looks forward to a constructive dialogue with the
PCAOB and all interested stakeholders on these important issues.”

PCAOB
member Jay Hanson, a former national director of accounting for
McGladrey & Pullen LLP and former chairman of the AICPA’s
Financial Reporting Executive Committee, supported the concept
release but urged the board to proceed with caution. “The primary
focus of the concept release is mandatory auditor rotation. Before
we determine whether that is in the best interests of investors and
the public, we will need to weigh carefully whether its benefits
would outweigh its costs and potential unintended consequences,”
Hanson said. “We also need to further analyze our inspection results
and other available information to determine whether audit
deficiencies are attributable to a lack of auditor objectivity and
skepticism and, if so, whether those symptoms are best remedied
through mandatory auditor rotation or some other measure.”

Tuesday’s
release and comments from several board members pointed out that a
2003 GAO
report concluded that “mandatory audit firm rotation may not be
the most efficient way to enhance auditor independence and audit quality.”

Board
member Daniel
Goelzer said he has “serious doubts”
that mandatory rotation is a practical or cost-effective way of
strengthening independence. “However, with nearly nine years of
inspections experience under our belts, the time is right to step
back and thoughtfully examine whether we need to deploy new tools
to promote independence,” he said.

Goelzer
urged those commenting on the PCAOB concept release to be
open-minded and creative in approaching the debate on audit
rotation. He said a cost-benefit analysis of mandatory rotation
would be critical.

“Firm
rotation would not be cheap for American business,” Goelzer said,
pointing to the GAO report, in which
large firms estimated that, under rotation, first-year audit costs
would increase by 20% as a result of work associated with getting
up to speed about the new client.

Goelzer
listed two potential alternatives to mandatory firm rotation should
new regulatory measures be needed: empowering the SEC or the PACOB to require
rotation on a case-by-case basis when a board inspection finds
that long tenure and lack of independence have combined to result
in an audit failure; or imposing special obligations on audit
committees to justify the retention of the auditor after some
period of time, such as 10 or 15 years.

“Objectivity,
independence, and professional skepticism are the foundations of a
high-quality public company audit,” the CAQ’s Fornelli said in her
statement. “The auditing profession is continually working to
improve performance in these areas and is eager to explore ways to
enhance confidence in the financial statement audit. It is important
that any new requirements in this area, including mandatory firm
rotation, meet the objective of improving audit quality. As stressed
by several board members, a cost-benefit analysis should be central
to the project. It is also important that, as they are doing with
possible changes to the auditor’s report, the PCAOB seek additional
input from the full range of stakeholders who will be significantly
affected by any changes in this area.”

According
to the concept release, proposals being considered outside the U.S.
would put in place measures such as regulation of engagement
tenders, mandatory rotation, dual-firm audits and “audit-only” firms.

If
the board determined to move forward with development of a rotation
proposal, it would also need to consider whether the requirement
should be paired with other changes to existing requirements, the
release states. Such procedures could include heightened internal
supervision or oversight requirements for the first year or two of a
new engagement, increased required communications between
predecessor and successor auditors, or other steps auditors could be
required to take during the transition from one firm to another.